T-Mobile's Brave New World Isn't So Brave After All

It's no secret that I'm not a fan of smartphone subsidies (or most subsidized markets in general, for that matter). When wireless carriers forcefully wedge themselves between manufacturers and consumers through a combination of device exclusivity, long-term service contracts, and subsidies, innovation suffers for it. That being said, an entity with far more sway than this mere Fool has spoken dramatically in favor of the subsidy model: the almighty market itself.

If one's different, one's bound to be lonely 
This is why T-Mobile's attempt to herald a brave new world without domestic carrier subsidies later this year is inevitably destined to fall flat. T-Mobile CEO John Legere recently said that the carrier's plan to offer Apple's (NASDAQ: AAPL  ) iPhone while also eliminating all smartphone subsidies is set to commence sooner than expected. We're talking about a time frame of three to four months, as opposed to the previous plan to implement the changes in six to nine months.

T-Mobile is taking on less risk than if some of it's larger rivals tried such a daring move because its customer base has a lower percentage of postpaid customers than the top two carriers. Here's the composition of the top four carriers' retail subscriber bases at the end of September, excluding wholesale connections and MVNOs.

Carrier

Postpaid

Prepaid

Postpaid %

Verizon Wireless

90.4 million

5.5 million

94%

AT&T (NYSE: T  )

69.7 million

7.5 million

90%

Sprint (NYSE: S  )

29.8 million

14.6 million

67%

T-Mobile 

20.8 million

5.7 million

79%

Source: SEC filings and earnings press releases.

Sprint-Nextel also has a large prepaid subscriber base due to its prepaid brands like Virgin Mobile, but AT&T and Verizon both enjoy postpaid penetration of at least 90% as evidence of how popular the subsidy model is among their respective subscriber bases.

T-Mobile has less to lose since it has relatively less contract customers, and far fewer subscribers in absolute terms, so the move is a risky bet to grow market share.

History lessons
Many have tried to rid themselves of the subsidy model, and all have failed. Apple boldly tried to sell the original iPhone with no subsidy but with the standard two-year contract. Needless to say, Apple had a bit of a tough time gaining traction in the first year, especially since the original model didn't have 3G data speeds. But look what happened as soon as Apple adopted the subsidy model with the iPhone 3G.

Source: SEC filings.

Apple failed to ditch the subsidy model, but not for a lack of trying. Consumers voted with their wallets overwhelmingly in favor of having carriers pick up most of the up-front cost.

More recently, Spanish carriers tried to ditch the practice, but are now rushing back to the warm embrace of the subsidy model. Vodafone (NASDAQ: VOD  ) -- which owns 45% of Verizon Wireless, the rest being owned by Verizon Communications (NYSE: VZ  ) -- axed subsidies at its Spanish subsidiary early last year only to see a customer exodus, promptly losing 639,000 subscribers in the second quarter. Rival Telefonica (NYSE: TEF  ) tried the same thing, and its customer losses totaled 830,000.

Meanwhile, competitors that stuck with the familiar subsidy model each grew their subscriber bases. By year's end, Vodafone Spain began offering subsidized smartphones again. Telefonica Digital director Tracy Isacke admitted that the move "was a disaster," specifically warning T-Mobile against following in its footsteps.

Is T-Mobile or the market wrong?
In an interview with Reuters at CES just this week, Verizon CEO Lowell McAdam said his company was open to the idea of getting rid of subsidies, except that customers just plain prefer them. He added:

It's very intriguing. Every carrier has thought about doing away with subsidies. But I don't think U.S. consumers are ready to buy an iPhone for $700.

Good luck, T-Mobile. You're going to need it if you hope to prove the market wrong.

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